Portfoliopractice IFRS Accounting of Pension Obligations

8/12/2019 Portfoliopractice IFRS Accounting of Pension Obligations

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Pension

IFRS Account ng

o PensionO igations

Highlights

Understand. Act.

ForInstitutiona

lInvestor

UseOnly.


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PortfolioPraxis: Akademie

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Pension

Content

Imprint

5 Intro uction

5 Define Contri ution vs.Define Benefit P ans

6 Define Contri ution P ans

8 Define Benefit P ans

Allianz Global Investors

Europe GmbH

Mainzer Landstrae 1113

60329 Frankfurt am Main

Global Capital Markets & Thematic Research

Hans-Jrg Naumer (hjn), Dennis Nacken (dn), Stefan Scheurer (st),

Maximilian Loebermann (ml)


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IFRS Accountingof Pension Obligations

International accounting, in particular on the basis of Inter-national Financial Reporting Standards (IFRS), has becomeincreasingly important in recent years. This developmentdates back at least to the so-called IAS Regulation of the Euro-pean Union of 19 July 2002 (No. 1606 / 2002). This regulationrequires European enterprises listed on a European exchangeto prepare their consolidated financial statements in accord-ance with International Financial Reporting Standards,beginning financial year 2005.

Dr. Martina Btzelhas been working in the Pensions department of Allianz

Global Investors KAG since mid-2007 and was appointed Managing Director

of Allianz Treuhand GmbH in September 2010. Following an apprenticeship in

banking with Deutsche Bundesbank, she studied economics as well as business/

economics education in Mainz. After having obtained her doctorate in economic

policy, she worked from 2001 to 2007 as consultant and executive assistant at

Dr. Dr. Heissmann GmbH (now Towers Watson).

Michael Heim is a DAV actuary and an IVS-examined actuarial expert for

pension schemes at Allianz Global Investors Pensions department. After his

studies in business mathematics at Ulm University he started his career

with Allianz in 1997. He has more than 15 years experience in the field of

occupational pension schemes.


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1. Introduction

Within IFRS, Standard IAS 19 Employee Ben-

efits (IAS: International Accounting Standard)

governs the accounting of employee benefits.

Employee benefits include:

short-term benefits

(e. g. wages, salaries, paid annual leave),

long-term post-employment benefits

(e. g. retirement benefits),

other long-term benefits

(e. g. jubilee benefits, claims from

working-life time accounts), and

termination benefits (e. g. termination

payments).

The majority of the content of IAS 19addresses post-employment benefits, i. e.

requirements that pensions be accounted

for under IFRS.

Pensions in Germany can be classified accord-

ing to the five ways of implementing them

pension commitment, direct insurance,

German Pensionskasse, pension funds and

support funds (Untersttzungskasse).

As part of employee remuneration or as a

supplement to pensions, increasing use hasalso been made in recent years of so-called

working-life time accounts. Among other

reasons, against the background of this very

diverse and sometimes complex array of

pension schemes, it is always a challenge

for German IFRS adopters to properly and

yet practically apply the accounting rules in

IAS 19, which are heavily influenced by

Anglo-American accounting rules, to the

specific German situation.

The aim of this presentation is to outline

the basic features of the regulatory content

of IAS 19 for long-term post-employment

benefits, while providing a means of classi-

fying and applying the regulations taking

into account the situation in Germany.

For selected topics, explanations will be pro-

vided on specific national accounting features

for the German balance sheet in accordance

with the German Accounting Law Moderniza-tion Act (Bilanzrechtsmodernisierungsgesetz

BilMoG) and German tax accounting

pursuant to the German Income Tax Act

(Einkommensteuergesetz EStG). In an

explanatory note, Contractual Trust Arrange-

ments (CTA) will be introduced as an alterna-

tive liquidity-friendly solution for the external

funding of pension obligations in accordance

with both the German Commercial Code

(HGB) and IFRS.

2. Defined Contribution vs.Defined Benefit Plans

hile a distinction is made in German

accounting between direct and indirect

pension obligations, the important distinction

under IAS 19 is between:

Defined Contribution Plansand

Defined Benefit Plans.

In a defined contribution plan, the contribu-

tions (e. g. to a pension fund) are recognised

as an expense in the period in which they

are incurred. If the employer matches the

amount and timing of his contributions to

obligations for each accounting period, it is

not necessary to recognise further liabilities.

The accounting for defined benefit plans

is more complex: using actuarial assump-

tions and methods, pension obligation andexpenses are identified and compared with

the separated assets or resulting return used

to meet the obligation.


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3. Defined Contribution Plans

3.1 Definition

Under IAS 19.7, a defined contribution plan is

defined using the three following cumulative

equirements:

1. Fixed contributions:The company only

has the obligation to make contributions

to the plan. The amount of the benefits is

based on these contributions, including the

resulting investment return.

2. Separate entity:The contributions are

paid to an external pension provider

(e. g. a pension fund) that is legally

separate from the company.

3. No legal or constructive obligation forfurther contributions:The company must

not have any subsidiary responsibility or

supplementary contribution liability, e. g.

in the case of negative investment per-

formance. Similarly, a positive investment

performance may not lead to reductions in

contributions or refunds of contributions.

n a defined contribution plan under IAS 19.7,

the company consequently bears no risks,

either biometric risks nor investment risks,or any other obligations associated with

the pension plan.

3.2 Accounting

The IFRS accounting for defined contribu-

tion plans is comparatively simple: For each

accounting period, the amount recognised and

presented in the notes as pension expense is

the contribution amount resulting from the

underlying pension plan formula (in exchangefor the employees service in the same period).

Because the companys liability, consisting

of this contribution, can be clearly identified,

and the company then fulfils this obligation

by making the contribution, accounting for

defined contribution plans in general does

not require any actuarial assumptions or

assessments. Only if the contribution is due

more than a year after the end of the account-

ing period in which the employee rendered

the service the future payment must be dis-counted. This discount is based on the actuarial

interest rate of defined benefit plans.

CompanyContributions

Pension Fund

EmployeeRisks and rewards lie

with the employee

Benefits

Service Wages andcontribution commitment

Figure 1: Structure of defined contribution plans

ource: Own research, Allianz Global Investors Pensions

Example

In the US, ABC company promises its

employees an annual contribution of 2 %

of pensionable salaries into the XYZ pen-

sion fund. The company does not incur

any risks or obligations (e. g. negative

investment performance) beyond thecontributions.


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The balance sheet is impacted by defined

contribution plans only if the company has not

matched the timing and amount of its contri-

butions to obligations during the accounting

period:

A liability is incurred when the plan is under-funded, i. e. the amount paid is lower than

the contributions due (deferred liability).

An asset is recognised when the plan is over-

funded, i. e. the amount paid is greater than

the contributions due (prepaid expense).

Once a companys commitment to (match-

ing) contribution payments has finally been

fulfilled, no further consideration regarding

the recognition of liabilities is necessary.

Contributions are paid to a legally separateentity. This entity is exclusively responsible

for the future payments to beneficiaries. The

company itself no longer has access to the

plan assets after payment of the contributions.

The company is then no longer to be consid-

ered the legal or economic beneficiary of the

assets, which are attributable to the eligible

employees and are not to be recognised on

the balance sheet of the company.

3.3 Practice: Do Defined Contri-bution Plans Exist in Germany?

Due to the employers subsidiary responsibil-

ity (see 1 para. 1 German Company Pension

Act), there are no defined contribution plans

in Germany following a strictly formal inter-

pretation of IAS 19.7. A word of caution: this

means that the term Defined Contribution

Plan, which we will be using throughout this

document, is not directly applicable in any

discussion concerning the German systemof pension plans. In many instances, a more

accurate term might be Contribution-

Oriented Plan

Even contribution-oriented plans should

initially be classified as defined benefit plans.

However, in specified circumstances, IAS 19

permits the treatment of these commitments

as defined contribution plans. This applies, in

particular, for so-called insured plans accord-

ing to IAS 19.39.

An insured plan is defined as a pension plan

whose benefits are financed through thepayment of insurance premiums. Plans of

this type can be treated as defined contribu-

tion plans unless the company has a legal or

constructive obligation to:

pay the employee benefits directly when

they fall due, or

pay further amounts if the insurer does not

pay all future employee benefits relating to

employee service in the current and prior

periods.

Question: Do the insurance-based solutions

in Germany, such as direct insurance, meet

the conditions for insured plans?

The prevailing opinion of the accounting

working group of the DAV / IVS Committee

(DAV: German Actuarial Association; IVS:

German Institute of Actuarial Experts) is that,

in insurance-based solutions, the final liability

is to be considered only as a contingentliability. Direct insurance, German Pensions-

kasse and pension funds can in general be

classified as insured plans in accordance with

IAS 19.39, and thus as defined contribution

plans, if the following criteria are met:

The company is the policyholder and

thus is liable for the contributions.

The employee is the insured person

and has the right to the benefits.

The employee has a legally enforceableright vis--vis the pension provider.

The pension provider guarantees the

benefits in compliance with regulatory

requirements.

The guaranteed benefits are based solely

on the contributions paid, plus any guaran-

teed interest, less cost and risk premiums.


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Pension FundFunding

Indirect commitment

BenefitsService

Wages and benefitcommitment

Employee Employee

CompanyRisks lie withthe company

CompanyRisks lie withthe company

Direct commitment

Service

Wages and benefitcommitment

Benefits

Figure 2: Structure of defined benefit plans


The surplus will be credited to

the employee.

Fully vested benefits are fully funded upon

termination of employment.

The amount of the post-employment

benefits is determined by the amount of

capital reserves. Pension adjustments depend on

policyholder bonus.

inally, the classification of an insurance-

ased solution as defined contribution plan

equires approval by the companys auditor.

4. Defined Benefit Plans

4.1 Definition

n general, every pension plan is a defined

enefit plan unless it definitely meets the

equirements for classification as a defined

contribution plan. Pursuant to IAS 19.25,

if there is any doubt, this distinction which

is sometimes not that simple must be

ade based on the economic substance

of the plan.

Defined benefit plans are characterized by the

fact that as opposed to defined contribution

plans the risks and obligations of the pen-

sion commitment remain with the company

even after the accounting period.

4.2 Accounting

While it is relatively simple to determine the

expense of contributions for each account-

ing period for defined contribution plans, the

(unknown) expense for each period, i. e. the

contribution required for financing the pen-

sion benefit, must be determined actuarially

on the basis of the (known) benefit when

ExampleThe company XYZ Inc. grants retirement

benefits to its employees. The lifelong

pension benefit amounts to 1 % of last

gross salary before retirement for each

eligible year of service. The company

bears all risks and obligations from the

pension commitment, such as the invest-

ment and longevity risk.


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accounting for defined benefit plans. When

these actuarial calculations are made, the

following accounting principles in particular

must be taken into consideration:

Suitable probabilities for the occurrence of

biometric risks of death, disability, etc. Discounting of future benefits using an

actuarial interest rate appropriate for the

maturity

Economic assumptions for trends and

adjustments of pension benefits (e. g. cost

of living and income)

4.2.1 Accounting principles

Under IFRS accounting for defined benefit

plans, a basic distinction is made betweendemographic valuation assumptions and

economic valuation assumptions. While

demographic assumptions reflect the

characteristics of the pension plan partici-

pants who are entitled to benefits, economic

assumptions are determined by macroeco-

nomic as well as company-specific indicators

and trends. In accordance with IAS 19.73, all

actuarial assumptions must be established in

such a way that they meet the best estimates.

Demographic Valuation Assumptions

The primary goal of demographic assump-

tions is to describe the current status andthe expected development of the number of

people to be covered by the pension plan.

The most important parameters for demo-

graphic assessment are the probabilities

for the occurrence of the biometric risks of

death and disability.Although these prob-

abilities could, in principle, be determined

individually for each set of people to be

assessed, due to insufficient set size and

excessive cost, statistical analyses are usually

based on generally accepted actuarial tablesfor probabilities of death and disability. In Ger-

many, the so-called Heubeck actuarial tables

(current actuarial tables: Heubeck 2005 G

by Klaus Heubeck) are customarily used for

IFRS accounting of pension liabilities. These

actuarial tables can also be customised for an

individual company by applying modifications

(increase or reduction of probabilities).


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liquid market for such corporate bonds, the

market yield on government bonds may be

used alternatively (taking into account a risk

premium to compensate for the difference in

credit quality). If there is no sufficiently active

market for very long-term bonds (which is

a particular issue for maturities longer than30 years), the discount rate is derived using

mathematical extrapolation methods. Histori-

cally, discount rates in accordance with IAS 19

have periodically been subject to significant

fluctuations over time because of the closing

date principle, with corresponding effects

on the amount of the pension obligation: A

higher discount rate ceteris paribus reduces

the pension obligation, while a lower discount

rate ceteris paribus increases the pension

obligation.

Other demographic assessment parameters

to be taken into consideration include

employee fluctuation and assumptions about

etirement age or the retirement behaviour of

ension beneficiaries. Fluctuation probabili-

tiesare generally derived individually for each

company as a function of gender, age andservice time. Actuarial analyses have shown

that taking fluctuation probabilities into con-

sideration may reduce pension obligations by

up to about 0.5 %, which means that it has a

ather small impact on the valuation of pen-

sion obligations.

Retirement agefor valuation purposes must

e in accordance with the provisions of the

ension plan (fixed / earliest age from which

etirement benefits may be drawn). In prac-tice, the most likely retirement age is very

often used as the basis for the assessment.

The German Income Tax Directive R 6 a EStR

states in paragraph 11 that for some or all

ension obligations, the earliest possible date

for early retirement claims from statutory

ension can be used as the date of entry into

the benefit plan. This guideline is often

followed in the IFRS valuation of pension

obligations.

Economic Valuation Assumptions

The central economic assumption is the

discount rateat which future benefits are dis-

counted to the valuation date. The discount

ate should, in principle, reflect the time value

of money and be based on the yields of high

quality fixed-income corporate bonds on the

valuation date. In practice, high quality cor-

orate bonds usually means corporate bonds

ated at least AA (using the terminology oftandard & Poors). The maturity and cur-

ency of the bonds and the pension obligation

should also match. Since the introduction

of the Eurozone, there has generally been a

sufficiently liquid market for corporate bonds

denominated in Euro to determine the dis-

count rate. If, however, there is no sufficiently

National accounting

While the determination of the dis-

count rate under IAS 19 grants a certain

amount of leeway for calculation and

interpretation, the German Accounting

Law Modernization Act clearly states that

the discount rates determined and pub-

lished monthly by the Deutsche Bundes-

bank, based on a market-oriented aver-age interest rate corresponding to the

predicted residual maturity of the obliga-

tion, are to be applied for discounting

pension obligations in the HGB balance

sheet. The only option granted is that, for

simplification purposes, a uniform inter-

est rate may be used for the entire pen-

sion plan based on a maturity of 15 years.

Among the economic evaluation parameters,

the IFRS financial reporting of pension obliga-

tions also subsumes trend assumptionsand

the return on plan assets. In contrast with the

closing date principle under German tax law,

the valuation of pension obligations under

IAS 19 explicitly calls for taking into account


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Accounting principles pursuant to IAS 19 rev. 2011

Objective: Realistic valuation through

Biometric assumptions (in particular death, disability)

Fluctuation probabilities

Retirement age/retirement behaviour

Best estimate principlein accordance withIAS 19.73

unbiased and mutually compatible assumptions,

assumptions that are neither imprudent nor excessively conservative,

assumptions that reflect the economic relations.

Discount rate

Return on plan assets

Trend assumptions (e.g. pension and wage trend)

Demographic Valuation Assumptions(company-specific assumptions)

Economic Valuation Assumptions(company-specific assumptions and

macroeconomic assumptions)

=

Figure 3: Accounting principles pursuant to IAS 19 rev. 2011

Source: Own research, Allianz Global Investors Pensions

the expected future changes and trends in

the valuation bases for pension benefits. In

particular, dynamic effects of current pension

benefits (so-called pension trends) are to be

included in the calculations, and dynamic

salary trends must be taken into account for

salary-linked pension plans.

With the revised version of IAS 19 rev. 2011

published on 16 June 2011, the return on

plan assets(expected return on plan assets

in the terminology prior to IAS 19 rev. 2011)

was substantially revised. For accounting peri-

ods starting from 1 January 2013, the appli-

cable discount rate for the calculation of the

pension obligation is implicitly used as return

rate for the plan assets as well. Accordingly,

the return on plan assets will no longer be

determined individually for the company, and

the allocation of the plan assets is irrelevant to

its determination.

4.2.2 Defined Benefit Obligation

Definition

The value of the pension obligation on clos-

ing date is designated in IFRS accounting of

defined benefit plans as the defined benefit

obligation (DBO). In actuarial terms, the

defined benefit obligation represents the total

present value of the accrued pension obliga-

tion that results from the services rendered by

the employee during the accounting period

and in previous periods.


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Pensionobligations(cumulative)

Agex + 1

Premium x

Premium y

y + 1 65x y

Figure 4: DBO process using the PUC method and

increase in funding premium over time

National accounting

While the German Accounting Law

Modernization Act does not require an

explicit evaluation method for the HGB

balance sheet, in German tax accounting

pursuant to Section 6 a EStG, only theso-called partial valuation method (Teil-

wertverfahren) may be applied.

Valuation / Determination

The objective of actuarial valuation methods

is to determine the value of the pension

obligation or of the premium required for

financing the pension obligation during the

appropriate period.

Under IAS 19, since 31 December 1999, the

rojected Unit Credit Method (PUC method)

as been explicitly required as the actu-

arial valuation method for the IFRS balance

sheet. The Projected Unit Credit Method is a

valuation procedure from the aggregation

ethods class. Under aggregation methods,

the amount of the pension obligation is calcu-

ated as the sum of the expected future bene-

fit payments discounted on the respective

closing dates and weighted with their prob-abilities, provided they have been accrued by

the reporting date. Based on the individual

obligation resulting from a classic defined

enefit plan, the premium required to fund

the pension obligation increases over time,

as the discount period continues to shorten.

A particular characteristic of the Projected

Unit Credit Method is that the value of the

pension claims on each reporting date is not

based on reporting date assumptions, but

instead is anticipated or determined (henceprojected) by taking into account future

changes of the key valuation parameters, such

as salary and pension trends.


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National accounting

In contrast to the three criteria under

IAS 19, for balance sheets in accordance

with German HGB, plan assets mustonly meet two requirements: exclusivity

of purpose and insolvency-protection.

A transfer of assets to an independent

entity is not necessary in contrast to

IAS 19. As a result, there may be a bal-

ance sheet effect in the HGB balance

sheet through the pledging of a securi-

ties account, e. g. for the purpose of

covering a managing partner pension

commitment. For exclusivity of purpose,

the Accounting Law Modernization Actrequires that plan assets be liquid at

all times to cover pension obligations,

which excludes operating assets (such as

owner-occupied real estate) from use as

plan assets for the HGB balance sheet.

4.2.3 Plan Assets

While pension obligations in Germany are

traditionally often financed internally through

investments that are not matched with the

obligation, but instead used for the core

business of the company (so-called internalfinancing), in the Anglo-American world the

primary method used is external financing

of the obligation (so-called outside funding).

With outside funding of pension obligations,

designated assets protected against the insol-

vency of the sponsor are accumulated outside

the company; these assets are exclusively

reserved for fulfilling pension obligations

(so-called plan assets).

DefinitionIAS 19 refers to assets as plan assets, i. e.

assets that must be offset or netted against

the underlying pension obligation, if the fol-

lowing three criteria are cumulatively met:

1. Separation( held by an entity (a fund)

that is legally separate from the reporting

enterprise ). The assets must be out-

sourced to an independent entity (e. g. a

trust / CTA solution), which has the sole pur-

pose of financing, paying out and ensuringbenefits. Repayments to the company may

only be made if:

there is excess funding, i. e. if the pen-

sion liabilities can be fully serviced by the

remaining plan assets, or if

the external entity reimburses the com-

pany for benefits that the company has

already paid to the pension beneficiaries

(known as Reimbursement).

2. Exclusivity of purpose( available to be

used only to pay or fund employee benefits) The plan assets are used exclusively for

payment or financing of benefits.

3. Availability in case of insolvency( are

not available to the reporting enterprises

own creditors (even in bankruptcy) )

The assets must be unavailable to the credi-

tors of the company particularly in the

case of bankruptcy.

The plan assets consist of the funding pro-

vided by the company and the returns earned

less benefit payments. The assets may com-

prise financial assets (e. g. shares, bonds,

mutual funds, qualifying insurance policies),

property, plant and equipment (e. g. machi-

nery) or real estate. Financial instrumentsissued by the company itself (i. e. treasury

shares) may be suitable as plan assets if they

are transferable. In particular, the criterion of

transferability is satisfied when the assets are

freely tradable.

The approval of plan assets under IFRS and

HGB always depends on close coordination

with the responsible auditor.

The classification of plan assets under IFRS

and HGB and the consequences of these

different definitions can be summarised as

follows:


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Plan assets under IFRS

Securities (e.g. special or mutualfund units) in CTA solutions

Pledgedsecurities account

Owner-occupied real estate orloan to the sponsoring company

in CTA solutions

Unpledgedsecurities account

No plan assets under IFRS

Plan assets under HGB

No plan assets under HGB

Figure 6: Consequences of the different definitions

of plan assets under IFRS and HGB


Valuation / Determination

Under IAS 19, plan assets are to be measured

at fair value as of the reporting date. Fair value

generally corresponds to the observed marketvalue or value on a securities exchange, which

is usually easily determined, particularly for

an investment in the form of financial instru-

ments. Difficulties in determining fair value

may occur for some assets, such as property,

plant and equipment or real estate. In such

cases, fair value is to be determined in the

best possible way, e. g. through appropriate

valuation procedures and expert opinions.

For qualifying insurance policies that securethe benefit commitments by fully matching

the amount and timing of those benefits,

the fair value of the insurance contract is

equivalent to the present value of the com-

mitments made for future benefits (Defined

Benefit Obligation) (so-called correspond-ing measurement). Therefore, an economic

effect in the IFRS balance sheet comparable

to a defined contribution plan is achieved

through this full offsetting. Nevertheless,

in this case as well, disclosure requirements

for the notes to the balance sheet continue

to be relevant for the defined benefit plan.

If the promised benefits and the benefits

secured through qualifying insurance policy

do not match, the asset value of the insurance

contract is usually presented as fair value andoffset with the pension obligation.

Requirements Plan assets under IFRS

Transfer to a legallyseparate entity No requirement

Identical requirement under IFRS and HGB

Availability (liquidity)for fulfilling pension obligations

Assets must be available exclusivelyand at all times for pension liabilities

(no assets that are necessaryfor operations)

Plan assets under HGB

1. Separation

3. Insolvency-Protection

2. Exclusivity of Purpose

Figure 5: Different definitions of plan assets under IFRS and HGB



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National accounting

With the Accounting Law Modernization Act, the valuation of plan assets at fair value

(rather than at cost) is also applicable for the first time in the HGB balance sheet.

Trusts

A trust solution (Contractual Trust Arrangement, CTA) can be used to hold assets as plan

assets for funding pension obligations: As a vehicle set up by a single company or often

more efficient by making use of a multi-employer trust, such as Allianz Treuhand GmbH.

Using a multi-employer trust, companies can participate regardless of their affiliation, size,

and the scope of their existing obligations, and achieve a balance sheet effect by offsetting

benefit obligations and plan assets in both IFRS and the HGB balance sheets.

How does a trust work, in particular in the multi-employer form? For external funding and

insolvency protection of pension obligations, the company enters into a trust agreement

with the trustee, and on this basis, transfers the assets necessary to cover these obligations.The actual administration of the trust assets is usually outsourced to a separately appointed

asset manager. According to the trust agreement, the trustee becomes the legal owner of

the transferred assets. He may only use the assets in order to provide or finance the benefits

promised in the pension plan, i. e. the trust assets are strictly reserved to the defined purpose.

This applies even if the employer / trustor should become insolvent. In this case, the employee

can apply directly to the trust to receive the promised benefits. However, the trust does not

provide any guarantee, but pays out the benefits only if and insofar as the necessary funds

were transferred from the employer. The trust structure is called double-sided, because

the trustee acts both as administrative trustee for the employer as well as security trustee for

the employee. However, a contractual relationship exists only between the company and the

trustee; the security trust is a contract for the benefit of third parties, i. e. the beneficiaries ofthe pension plan.

Using a trust solution for creating plan assets offers a number of advantages:

Foremost is flexibility, because there are no set guidelines in a trust solution as to amount

or timing of contributions by the employer. The funding of the trust may be based on the

individual circumstances of the company, depending, for example, on the intended level of

external funding or the available liquidity.

The netting of trust assets and pension obligations of the trustor company is possible

because while the trust assets do legally belong to the trust, economically they remain allo-

cated to the trustor company. The criteria for plan assets, which are set according to interna-tional accounting rules and the German Commercial Code, are fulfilled by an appropriately

designed trust agreement. The final approval for offsetting the trust assets with the pension

obligations lies with the auditor of the company.

In German tax accounting, the pension obligation is not offset with the pension assets; the

trust remains invisible for tax purposes, in a manner of speaking. This leaves the tax holiday

effect of the provision in place. Important for the employees: The external funding of the

trust will not affect the tax treatment of employee contributions or benefits. Since the

pension plan remains untouched under labour law by external funding through the trust,

no consent of the individual employees or of the works council is required for the implemen-

tation of a trust solution.


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In addition, a trust solution also improves the insolvency protection for the benefit commit-

ments. While a statutory insolvency protection for occupational pensions in Germany already

exists in the form of the German Pension Protection Association (Pensions-Sicherungs-

Verein PSV), this applies only to statutory vested rights within the scope of pension law

and benefits in the payout-phase. This means, in turn, that occupational benefit claims are

not protected against insolvency if, for example, they are only contractually vested or if theyexceed the protection limits of the PSV. Even accrued benefits from deferred compensation

in the last two years before insolvency if exceeding the contribution threshold of 4 % of

statutory pensionable salary are not legally protected against insolvency. The benefit claims

of individuals who are not subject to the pension law, such as the controlling owner-manager

of an enterprise, remain completely unprotected. In all these cases, private law insolvency

protection can be set up by the trust. In addition, the trust can be used for providing insol-

vency protection for other obligations vis--vis the employees, e. g. from time accounts or

part-time retirement.

In multi-employer models, a broad range of capital investment structures (including hybrid

structures) can be put in place with investment funds and insurance products. Biometric riskscan also be hedged through the integration of the appropriate insurance components into

the overall concept.

Assetmanager

Benefitobligation

Benefitentitlement

Company

Employee

Investment

Transfer of assets

Trust agreement

Benefit claim

Claim procedure

Treuhand GmbHor e. V.

Figure 7: Contractual Trust Arrangement



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17

4.2.4 Pension Expense

In the past, the structure and recognition of

pension expense under IAS 19 was character-

ized by numerous accounting options that

sometimes were contrary to the IFRS account-

ing principle of true and fair view. The

revised version of IAS 19 rev. 2011 brought

many changes in this area, with the objec-

tive of making classification as unambiguous

as possible and improving comparability of

income and expense components. Pensionexpense can now be categorised as:

Service cost

Net interest

Remeasurement.

Service Cost

Service cost will be recognised in profit and

loss and calculated prospectively by the

actuary. It includes:

Current service cost Past service cost and

Settlements.

The current service costis determined using

the Projected Unit Credit Method. It cor-

responds to the actuarial cash value of the

benefit components that are newly accrued by

the (active) employees during the accounting

period. Analogous to the defined benefit obli-

gation, the following applies: All other things

being equal, a higher discount rate reducescurrent service cost, and a lower discount rate

increases current service cost.

Past service costmay result from the subse-quent improvement or deterioration of a pen-

sion plan. Unlike original current service cost,

which reflects the benefit components newly

accrued in the current accounting period,

past service cost always relates to previous

accounting periods. As a rule, past service

cost was previously recognised over a certain

period of time as a separate item in pension

expense. Under IAS 19 rev. 2011, it is now

subsumed as part of service cost and is to be

fully and immediately recognised in the year ofthe plan change. The definition of past service

cost was also expanded under IAS 19 rev. 2011

and now also includes effects associated with

curtailments. Curtailments can arise at the

closure of an operation, during restructuring

or closures of pension plans. In the case of a

curtailment, the company must be committed

to substantially reducing the circle of persons

entitled to benefits or to altering the pension

plan so that significant portions of future

years of service or salary increases lead onlyto reduced pension claims or to no pension

claims.

ith a settlement, the company transfers,

without any extended liability, the pen-

sion obligation for which it is responsible

to another entity (e. g. another company or

pension provider), or the pension obligation is

extinguished by the payment of a termination

indemnity. In accordance with IAS 19.113, the

conclusion of an insurance contract does notlead to a settlement, if the employer remains

subject to the extended liability to pay benefits.


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Pension

18

The new IAS 19 rev. 2011 provides no guide-

ines regarding the explicit presentation of

the individual pension expense items in the

income statement. Service cost is, in practice,

usually presented as personnel expense and

ecognised as part of operating profit in profit

and loss.

Net Interest

et interest, which is also recognised in profit

and loss, represents the interest income or

expense resulting from the net liability or

from the net assets (so-called net defined

enefit liability / asset as the difference

etween pension obligations and plan assets).

n the terminology of the previous version

of IAS 19, net interest comprised the sum of

the interest cost and the expected return onlan assets, while under IAS 19 rev. 2011 the

discount rate used to calculate the benefit

obligation is now to be applied to both figures

(see 4.2.1 Accounting principles). Expected

changes during the accounting period due to

ension payments or funding of plan assets

are taken into account. A simple mathemati-

cal expression of net interest is:

Net interest = (plan assets pension

obligation) x discount rate

possible , it will no longer be possible in the

future because of the net perspective.

By combining the interest expense with the

return on plan assets, all the risks and rewards

of the actual investment of plan assets are

now no longer recognised as an income com-

ponent of net interest, but are now presentedon the balance sheet within the framework of

remeasurement described below.

Remeasurement

At the end of the accounting period, devia-

tions naturally occur between the prospec-

tively measured values (i . e. the expected

values) and the actual values for the pension

obligation, plan assets, etc. The reasons for

this can, for example, be found in changed

discount rates, the occurrence of biometricrisks or unexpected developments of plan

assets. These discrepancies between the

expected and actual values are referred to as

remeasurement.

The valuation changes basically include all

the changes in the pension obligation and the

fair value of plan assets, as far as these are not

included in service cost or net interest, i. e.

they include in particular:

actuarial gains and losses on the liabilityside (e. g. conditioned by changes in the

discount rate) and

deviations in the actual development of plan

assets from the corresponding part of the

net interest allocated to plan assets (based

on the discount rate).

In contrast to the recognition of service cost

and net interest in the profit and loss state-

ment, the remeasurement is immediately and

completely recorded in equity, specificallyin the statement of comprehensive income

in accordance with IAS 1.81 (other compre-

n practice, net interest is generally option-

ally included in operating results or in the

financial results of the income statement.

Therefore, with regard to the income and

expense components of pension obligations,

comparisons of annual financial statements of

different companies continue to be of limited

value. Although it was questionable in busi-

ess terms, the presentation of interest costin financial results and expected returns on

lan assets in operating result was previously


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19

Pensions expense pursuant to IAS 19 rev. 2011

Recognition in OCI(Other comprehensive income)

Current service cost

Past service cost

Settlements

Service cost Net interest Remeasurement Interest cost

(Expected) Return on plan assets

On the basis of the discountrate for calculation of the DBO

All changes to DBO or fair valueof plan assets, provided they arenot taken into consideration inservice cost or net interest

Recognition in profit and loss

Figure 8: Classification and allocation of pension expense pursuant to IAS 19 rev. 2011

National accounting

In accordance with the provisions of

German commercial and tax law, the

pension provision is determined at the

end of each accounting period. The dif-

ference between the pension provisionsof the previous year, including benefits

paid in the accounting period determines

the pension expense to be recognised in

income.

hensive income (OCI)). There is no longer

any provision for deferred recognition in

income of these amounts, such as in the

framework of the corridor method, which

was done away with in IAS 19 rev. 2011.

The recognition of the remeasurement in

other comprehensive income protects theincome statement from excessive volatility.

This approach is, in practice, often referred

to as OCI or SoRIE method (SoRIE: Statement

of Recognised Income and Expense), an

approach that has been in the standard since

2004, and which had already been applied

in Germany before the introduction of IAS

19 rev. 2011. It has been used by about two-

thirds of DAX companies and has found broad

acceptance.

The following figure presents the classi-

fication and allocation of pension expense

for defined benefit plans pursuant to IAS 19

rev. 2011:

4.2.5 Balance Sheet Approach

The revised version of IAS 19 rev. 2011

improves the comprehensibility, transpar-

ency and comparability of the balance sheetapproach of defined benefit plans. In particu-

lar, this main goal of the new standard was

achieved with the abolition of controversial

accounting options (e. g. corridor method).


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Pension

20

4.2.6 Notes

The information disclosed in the notes of an

IFRS balance sheet (known as disclosures)

should enable the reader of the balance sheet

to understand and assess the economic fun-

damentals of the pension plan (IAS 19.120).Among other things, the following informa-

tion is to be included in the disclosures:

A general description of the type of pension

plan (e. g. length-of-service plan), including

the legal framework

The main actuarial assumptions (e. g. dis-

count rate, trend assumptions)

A reconciliation from the beginning to the

end of the accounting period for, among

other items, the pension obligation, planassets and balance sheet recognition

A breakdown of pension expense into its

individual components, including those

items in which they are recognised in the

income statement.

Within the scope of IAS 19 rev. 2011, the

disclosures on defined benefit plans have

also been subjected to various changes which

are intended to present, in more detail, the

characteristics and risks associated with thepension plan. The following changes are

examples:

Sensitivity analyses of the pension obliga-

tion for any significant actuarial assumption,

including explanations (sensitivity analyses

for example concerning the discount rate,

trends, retirement age and mortality rates;

only one assumption should be varied in

each case, i. e. there are no interactions

required among the various assumptions)

Example

The pension obligation is EUR 300,000.

a. Plan assets total EUR 200,000

The company has a Net Defined

Benefit Liability amounting to

EUR 100,000.

b. Plan assets total EUR 350,000

The company has a net defined

benefit asset amounting to EUR 50,000(at this point, information on the

special provisions concerning the

so-called asset ceiling under IAS

19.58 will be omitted).

The IFRS balance sheet recognition of

defined benefit plans is now the result of the

net difference between the benefit obliga-

tion and plan assets(so-called net defined

enefit liability / asset). Thus, both changes in

the benefit obligation and developments of

lan assets will, in the future, be immediatelyecognised in each accounting period, as part

of full balance sheet recognition. The result-

ing fluctuations on the balance sheet, which

ay be substantial, are not, however, directly

expressed in the income statement of the

company, but are recorded in equity using the

OCI or SoRIE method (cf. explanations on pen-

sion expense). The volatility of net obligations

or net assets to be recognised and the equity

implications may very well be subject to sig-

ificant increase. If there are plan assets, theoffsetting or netting of pension obligations

and plan assets is mandatory, not optional.

n simple terms, under IAS 19 rev. 2011, most

accounting options were abolished in the

accounting approach to defined benefit plans.

AS 19 follows the HGB accounting approach

already familiar from the German Accounting

aw Modernization Act, i. e. the net difference

of the pension obligation is presented net of

lan assets.


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21

Figure 9: Case study on IFRS accounting of defined benefit plans

Begin of period End of period

(actual/recognized)

Balance

sheet

Pension cost Liquid-

ityactual expected P&L OCI

Defined Benefit

Obligation(DBO)

begin of period

1.000

ervice cost 100 100 100

Interest cost (5 %) 50 50 50

Benefit payments 50 50 50

Remeasurements 40 40

Defined Benefit Obliga-

ion (DBO) end of period1.100 1.140 1.140

Plan assetsbegin of

period800

Contributions 00 100 00

Benefit payments 50 50 50

Return onplan assets (5 %)

40 0 40

Remeasurements 20 20

Plan assetsend of period 890 910 910

230 110 20 100

Information on the maturity profile of the

pension obligations

Information about any financial instruments

and strategies in the pension plans (e. g.

asset-liability matching).

The new disclosure requirements are not tobe considered a final check list, but rather

to complement the comprehensive nature

of the disclosures. With regard to the level of

detail of the disclosures, the company can still

decide on whether the objective of disclosure

of information has been sufficiently fulfilled.

4.3. Practice: Case Study on Ac-counting of Defined Benefit Plans

At the beginning of the accounting period,

the pension obligation amounting to 1,000

monetary units is opposed to plan assets of

800 monetary units. The company, accordingly,presents a pension obligation amounting to

200 monetary units in the balance sheet.

The changes and developments during the

accounting period and the resulting implica-

tions for the balance sheet approach, liquidity

and pension costs are shown in the table below:

Source: Own research, Allianz Global Investors Pensions


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Pension

22

The balance sheet value of the pension plan

at the end of the accounting period is the

et difference between pension obligation

and plan assets. The company now presents

a pension obligation in the amount of 230

onetary units.

n the income statement portion of the pen-

sion expense, the service cost and net interest

are both taken into consideration (consist-

ing of the interest expense for the pension

obligation and the interest income from plan

assets, in each case based on the discount

ate for calculating pension obligations). In

the income statement, a pension expense

amounting to 110 monetary units is recog-

ised as income.

The company records valuation changes at

the end of the accounting period resulting

from the pension obligations and the plan

assets in the amount of 20 monetary units

in equity in other comprehensive income

(OCI). In the terminology of IAS 19 rev. 2011,

a negative (positive) sign implies an actuarialloss (gain).

Pension payments to beneficiaries, which

the company withdraws in full from the plan

assets, impact liquidity, as well as the funding

of the plan assets in the amount of 100 mon-

etary units.


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23

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